With the debt ceiling discussions in full fearmongering mode and the Euro debt crisis causing increased global turmoil, there’s been an increase in the use of the term “bond vigilantes”.  And despite all these increasing debt fears we just can’t see any American bond vigilantes on the horizon.  In fact, every time this crisis in Europe seems to flare up and the risk off trade occurs, we see a dive in U.S. government yields.

Where in the world are these bond vigilantes?  Well, they don’t really exist.  As David Rosenberg recently showed, US government bond yields have an interestingly high correlation with Fed policy (88%).  Of course, for those of us who understand how the system works, the reasoning behind this is quite clear.  The US monetary system is quite different from that of Europe’s so there is no financing mechanism at the Federal level.  So, while muni bonds might be comparable to Greek bonds, the analogy doesn’t hold true for Greece and the US Federal government.  The result is that bond yields in the USA largely reflect Fed policy and the reserve drain that the US government bond market truly represents.   Thus, as previously mentioned, there are no bond vigilantes in the USA as there are in Europe:

There are no bond vigilantes to come after the USA for fear of solvency. There is simply no such thing. The only form of insolvency the USA faces is in the form of hyperinflation and that is a very different phenomenon than the one we currently are at risk of.

Comparing an EMU nation to the US Federal government is a terrible flaw that we see day after day. It contributes nothing but fear to the conversation and exposes the fear mongerer as having a severe misunderstanding of the workings of monetary systems. Well over a year ago I warned of this fear mongering. Luckily, we have not succumbed to it (and our economy is recovering – though slowly), but that hasn’t stopped millions from trying to scare the rest of us into believing that our Greek moment is right around the corner….”

Bond traders in the USA get this.  If there is one axiom that holds true in U.S. government bond markets it is “Don’t fight the Fed”.   I doubt that all US government bond traders understand the idea that there is no solvency issue at the US Federal level, but they do understand that the Fed essentially controls the entire curve via short-term policy moves. They know it because they’ve watched men like Niall Ferguson, (who has been ranting about surging US government bond yields for almost an entire decade) make this mistake based on faulty analysis.  And while Niall Ferguson can push political fear mongering that is wrong for nearly an entire decade and not get fired by his employer, the same cannot be said of bond traders who don’t have the luxury of being wrong for 10 years straight.

So, we’re likely to hear increasing banter from certain circles who are calling for higher yields in US government bonds as the vigilantes supposedly “wake up” and “force the issue”.  But as I’ve long maintained, we are a long way from higher rates in the USA or a bond market bubble collapse.  Yields will continue to reflect the low growth and low inflation environment that the Federal Reserve sees.


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Don’t we need the misconception about the American debt problems to keep the dollar in check? If everyone understood how things really worked, wouldn’t there be an absence of fear, a risk-free rate of zero, and a substantial erosion in the value of the dollar? Doesn’t the dollar get buoyed by the misguided and undereducated in Washington squawking about the debt? Aren’t the misguided going to strengthen the dollar at the expense of the economy, at least in the short-term? Shouldn’t I be long the dollar here?

  2. 1. 99% of the folks in Washington D.C. – IMO – haven’t got a clue why the USD(x) is going down or up.
    2. To say that rates in the US go down as a result of problems in Europe is sheer nonsense. If money is – supposedly – moving from Europe to the US then why did the german bund future outperform the US 10 year future.
    3. The only thing the FED can do is to increase or decrease liquidity. Mr.Market decides where that liquidity is going.
    4. When the USD is going up – like it does now – the whole “”kit caboodle”” could/will come crashing down. Like in 2008.
    5. Do bond traders in the US REALLY know the monetary system works ? I very much doubt it.
    6. The amount of debt does matters and therefore does the discussion on the debt ceiling does as well. In the current state it’s a matter of “”damned if you do or damned if you don’t””. A choice between two evils.

  3. Cullen,
    Thought this might be interesting. To me this seems similar to the “platinum coins” solution but without the coins.

    Ron Paul recently made (another) splash among economic pundits with his suggestion that the Treasury simply cancel the $1.6 trillion in its debt held by the Federal Reserve. That would immediately reduce the outstanding federal debt by the same amount, thus freeing up room for Treasury Secretary Geithner to continue meeting the government’s financial obligations even without a Congress-approved increase in the statutory debt ceiling. Paul argues that this debt cancellation is acceptable because the Fed just printed up the money out of thin air to buy the bonds in the first place. In other words, it’s not as if the Treasury would be reneging on its debts held by hardworking, frugal investors.

  4. A thoroughly enjoyable read. Ironic, since the most active ad here is a solicitation to send money to some organization using Ron Paul’s face, to support the Repub’s cause of forcing austerity and cuts on the middle class.

    Strange New World….

  5. I think I see how this unfolds. Bond haircuts, even voluntary ones, are classified by ratings agencies as a default.

    Therefore, get rid of the ratings agencies!!!!

    Looks like it already is in motion…


  6. The key here is that we are in a global balance sheet recession. That is the reason why what CR says makes perfect sense. In a balance sheet recession, there is virtually no risk of high inflation, and rather deflation and unemployment are the problems. Once those problems subside (could take some time – 3-7 years), then the Fed and Treasury need to reverse course and deleverage the public debt. We are currently witnessing a transfer of private over-leverage (debt) to public debt via the Fed and Treasury actions. At some point the reverse will be necessary. Outside of this, however, there has been so much corruption and bungling that things are very messy. Even this messiness, however, is intrinsic to this dynamic of leverage.

  7. Will,

    At least you’re right about #5. I know from first hand experience that very, very few bond traders or portfolio managers know anything about MMT. I like it that way. It gives me an edge. But I also know for certain that pragcap is on the daily must-read list of some bond pros.

  8. if the treasury and fed did that,

    1. that would be a default sina qua non.

    2. fed would lose all claims to independence. why would a market participant light a match to $1.6T worth of its assets?

    3. america then would be greece.

  9. the only was out is for the ecb to take default rated sovereign paper as collateral. ben is going to call trichet and say greece’s not so bad compared to some of the toilet paper the fed owns.

  10. Money is made when one person has knowledge that other don’t. Is it possible that MMT has caught on big with a lot of smart money players, but they are not interested in sharing this knowledge; because they want to capitalize on it first?

  11. Instead of bond vigilante’s, we get dollar vigilantes. When the Fed started QE2, it encouraged commodity speculators to bid the prices way above market value, leaving consumers no discretionary income to keep the economy growing. Bond vigilante’s haven’t come out of the woodwork yet, but nobody can predict when they will because it’s mostly driven by emotion.